22. Much of the discussion on the economics of the
Stern Review has centred on the use of a particular "discount
rate". In this context, the discount rate allows one to measure
the value of future costs and benefits in today's terms. A high
discount rate, for example, indicates a preference for consumption
now rather than in the future. Choosing an appropriate discount
rate, whilst a highly technical subject, is crucial to assessing
the extent of sacrifices the world should be taking now to prevent
or slow down climate change damage affecting future generations.
The issue of discounting across long time horizons raises awkward
questions of intergenerational equity, such as 'Should society
be attempting to maximise welfare across all generations,
or, alternatively, should it be seeking to equalise or
smooth welfare across all generations?' Choosing a lower
discount rate has the effect of promoting a reduction in
current consumption, so that the world inherited by future generations
is less damaged.
23. The Stern Review employed discounting assumptions
that have caused some controversy amongst academic economists.
Professor Ekins perhaps understated the debate when he said that
"there has been a fair bit of controversy about how he arrived
at his overall damage costs, in particular with the use of a discount
rate that some perceived to be too small".
Lord Lawson referred to the critique made by Professor Sir Partha
Dasgupta of Cambridge University:
[The discounting] part of Stern is not only highly
contestable but highly contested. Professor Dasgupta says it is
ridiculous and he has pointed out that if you accept Stern's [assumption
about intergenerational equity] it means that the people of this
generation should be saving 75% of their income for future generations.
As he says, that is absurd. That part of Stern is, I believe,
widely believed to be absurd.
Lord Lawson argued that the sacrifices expected of
the current generation should be set against the fact that future
generations are likely to be much richer and enjoy a better quality
The proposition is that we should ask the people
of this generation all round the world
to make considerable
sacrifices now in order that their great-grandchildren or great-great-grandchildren,
or whatever, who will be seven times as well off as they are today
rather than six times as well off. It is as if at the time of
the industrial revolution just under 200 hundred years ago people
were told that they should not embark on that process and burn
coal but use wind and water, which were well known technologies
at that time, so that we in this generation would not be as well
off than we are today. I do not think they would support that.
24. Sir Nicholas defended his discounting techniques
when we questioned him. He explained how there were two reasons
for discounting. The first reason was discounting for growth,
the idea that "in future, people may be better off than we
are currently. An extra unit of stuff in future therefore has
lower ethical value."
Rejecting Lord Lawson's allegation, Sir Nicholas stated that his
Review performed such discounting for growth in exactly the same
way as the Treasury would normally do.
25. The second reason for discounting, the pure time
discount rate, is the discounting of future events for no other
reason than that they are in the future, or, as Sir Nicholas described
it, "the issue of how far we should discriminate between
people by date of birth".
The Association of British Insurers pointed out that the pure
time discount rate chosen by Sir Nicholas, 0.1%,
contrasted markedly with the rate of 1.5% used in the Treasury
Green Book, the rate which is normally used by economists when
discounting future cashflows in public policy evaluations.
The Stern Review argued that standard treatments of discounting
were valuable for analysing marginal projects, but inappropriate
for the non-marginal impacts important for many aspects of climate
change. In a working
note for the Stern Review, Dr Cameron Hepburn of the University
of Oxford argued that the relevant discount rate for climate change
decisions should reflect the risk of "societal collapse"
(for example, an entire region or country succumbing to rising
sea levels) and, on this basis, should indeed be smaller than
the current Treasury rate of 1.5% and possibly 0% to a first approximation.
26. Sir Nicholas told us that the idea of discriminating
on the grounds of date of birth was an ethical position that was
"extremely hard to defend".
In his opinion there was little justification for such discounting
when conducting cost benefit analysis at the planetary level (as
with climate change), and argued that this approach was not unusual:
We are in pretty good company here in that [the
distinguished economists] Solow, Sen, Keynes, Ramsey and all kinds
of people have adopted the approach to pure time discounting that
we have adopted. It is not particularly unusual.
We note that some economists would disagree with
Sir Nicholas' view that choosing a higher pure time discount rate
was indefensible. Professor Nordhaus of Yale University, writing
in the Journal of Economic Literature, listed four possible
justifications for a different rate.
27. Professor Ekins thought that, despite the controversy
over the discounting assumptions used, Sir Nicholas' broad conclusion
that the damages from unabated climate change would greatly exceed
the costs of doing something about it and reducing the level of
emissions, was "absolutely right."
Simon Roberts from the Centre for Sustainable Energy argued that
the discount rate chosen was irrelevant to the central finding
of the Stern Review that the costs of inaction far outweighed
the costs of action:
It is very clear that whatever discount rate
is usedno matter how lowthe costs of inaction far
outweigh the costs of action. On that basis, even if one almost
entirely ignores future generations or treats them as if they
are already alive, you would still conclude that it justifies
significant immediate action in relation to climate change, rather
than worry too much whether it should be x% or y%.
That would be a level of focus on a specific that ignored the
broad conclusion that action is needed now rather than later.
28. Sir Nicholas was clearly aware of the significance
of the ethical assumptions he made in his Review:
We put the ethical questions at centre stage.
If one is talking about making decisions now which have an impact
over 50, 100, 150 or 200 years the ethics of how one makes judgments
as between changes in investments in the next few years and their
implications 150 years down the track raise some quite difficult
questions. We felt that the economics of policy could not really
be taken on without confronting those things.
29. At the time of publication, the Stern Review
offered only one discount rate possibility. Following some criticism
from academics, Sir Nicholas later published a Postscript
containing tables that showed the sensitivity of the Stern Review's
findings to different choices of discount rate. However, no arguments
were put forward explaining why other discount rates might be
preferred by other economists, which, had they been provided,
would have been helpful in facilitating debate about the relative
merits of different discount rates.
30. The Minister supported the assumptions underpinning
the Stern Review.
He told us that the current generation had a particular responsibility
in dealing with climate change and it was right that "we
should not regard the value of the world [in future] any less
than we do at the moment".
31. The choice of discount rate used in the Stern
Review is critical to its strong policy conclusions, because that
choice is an important factor in the calculation of the costs
(as valued today) arising from future climate change. We regret
that there was not greater discussion of discount rates in the
original Stern Review, including explanation and potential justification
of alternative rates. We welcome the eventual publication of discount
rate sensitivity tables in the Stern Review's Postscript, but
note that the attention that these alternative rates received
was substantially lower than might have been the case if acknowledgement
of, and arguments for, other discount rates had been provided
in the original Review.
Relying on adaptation
32. The most prominent strand of our inquiry was
the role of the Treasury in limiting UK carbon emissions. Yet,
however successfully this aim is pursued in the future, the UK
and the wider world have to begin to adapt to climate change now.
Regardless of future action, it is already certain that threats
such as rising sea levels and more unpredictable weather patterns
will make increasing demands on the Treasury's purse strings.
Some adaptation will be inevitable, but we considered it important
to examine where the balance lay between encouraging expenditure
on adaptation methods rather than cutting emissions.
33. Lord Lawson told us that, although he had not
calculated the monetary sum needed to adapt to climate change,
it was "quite clear that it would be substantially less than
the cost of going down the route of cutting back [on emissions]
He argued that an effective response to climate change would involve
close monitoring of the consequences of warming, adaptation to
those consequences where they were harmful and pocketing of benefits
when the consequences were beneficial.
He took the view that although the impact of climate change could
be severe, all kinds of other eventualities were possible, including
the chance that the world might enter a new ice age over the next
100 years. He also argued that there were much more urgent problems
to face such as terrorism, nuclear proliferation, and natural
disasters, and that the UK could not guard against every possible
contingency because it would be too expensive. He commented that,
in the near future at least, the UK should be focused on the dangers
arising from nuclear proliferation and international terrorism,
saying "we should be careful about future threats and be
careful not to spend resources unnecessarily".
For these reasons, he advocated limiting expenditure on cutting
back emissions, instead focusing on monitoring and adaptation
to the threat of climate change.
34. A response to the threat of climate change based
on adaptation would have the advantage of enabling each nation
to deal with the consequences piecemeal as and when they arose,
in contrast to the emissions reduction approach, which Lord Lawson
described as requiring an "extremely ambitious and implausible
international agreement before you can do anything worthwhile".
In Lord Lawson's strategy, poorer countries unable to adapt to
changes such as rising sea levels could receive financial assistance
from richer countries, which, in his view, was a "far more
practical approach [than mitigation of emissions] as well as being
far more cost-effective."
He thought that the financial aid required would be manageable
because of the economic growth in the developing countries that
the Stern Review predicts:
Although we should help these countries it must
be remembered that on the growth assumptions on which the Stern
projections of warming are based the living standards of the developing
world as a whole
will be higher in 100 years' time than
they are in the developed world today, which is great news if
those predictions can be believed. Most of the countries will
be able to afford most things themselves.
35. Kate Hampton from Climate Change Capital believed
that intelligent debate on adaptation had been slowed down because,
historically, "adaptation has tended to be used as a card
played by countries like the US and Saudi Arabia as a way to divert
attention away from mitigation".
Sir Nicholas argued that the balance between adaptation and mitigation
should not be viewed as a horse race and that both adaptation
and mitigation would be important. However, he disputed Lord Lawson's
argument that it made sense to see what happened before acting,
because of the significant risk that by then it would be too late:
We have to do both. I think that to see adaptation
as an answer to a risk of a 5°C or 6°C increase is not
realistic given the magnitude of the implications for the political
and human geography of the world.
The Stern Review paid attention to the risk of catastrophic
climate change, a scenario for which monitoring would simply be
inadequate and too late. Professor Ekins agreed that catastrophic
climate change risk was a growing theme in the scientific literature:
The single biggest change in the science over
the past 10 years since I have been looking at the issue is the
way in which scientists now perceive catastrophic costs to be
much more possible in the reasonably short term.
36. Lord Lawson's argument that adaptation was
cheaper, easier and more flexible than attempting to mitigate
emissions has its attractions. However, as Sir Nicholas Stern
pointed out in his Review and in evidence to us, relying on monitoring
and adaptation alone could prove to be too little, too late. The
fact that adaptation will be required in the short to medium term,
regardless of mitigation efforts, does not absolve the UK from
its responsibility to reduce its carbon emissions. We support
Sir Nicholas' recommendation that the Government pursue a twin-track
approach: working to reduce emissions to a sustainable level,
while at the same time committing sufficient resources to the
monitoring of climate trends and adaptation, both in the UK and
14 Q 129 Back
Q 1 Back
Ev 132 Back
Q 251 Back
Q 325 Back
Stern Review, p vi-vii Back
Ibid., p vi Back
Ibid., p vi Back
Stern Review, p vii Back
Q 194 Back
Stern Review, p vi Back
hereafter referred to as "the Minister" Back
Q 275 Back
Q 359 Back
Ev 143 Back
Qq 275-276 Back
Stern Review, p vii Back
Ibid., p viii Back
Ibid., p vii Back
Long-term opportunities and challenges for the UK: analysis for
the 2007 CSR, HM Treasury, November 2006, para 4.37, p 59 Back
Treasury Committee, Fourteenth Report of Session 2006-07, Globalisation:
prospects and policy responses, HC 90, Q 315 Back
Q 277 Back
Q 214 Back
Q 276 Back
2007 Pre-Budget Report and Comprehensive Spending Review, HM Treasury,
p 118, paras 7.27-8 Back
William D. Nordhaus, A Review of the Stern Review on the Economics
of Climate Change, Journal of Economic Literature, 45(3): 686-702,
September 2007, pp 691-2 Back
Q 204 Back
"The Economics and Politics of Climate Change: An Appeal
to Reason", speech by Rt Hon Lord Lawson to the Centre for
Policy Studies, 1 November 2006, p 1 Back
Q 205 Back
Q 254 Back
Q 1 Back
Q 200 Back
Q 199 Back
Q 133 Back
Q 135 Back
Q 133 Back
The Stern Review uses the value of 0.1%, rather than 0%, to allow
for the possibility that humankind might suffer extinction from
some catastrophe other than climate change, before climate change
has its full effect. That, in Stern's view, is the only valid
reason to value future generations less than our own. Back
Ev 121 Back
Stern Review, p 23 Back
Discounting climate change damages: Working note for the Stern
Review, Cameron Hepburn, pp 21-22 Back
Q 133 Back
Q 139 Back
Journal of Economic Literature, vol 45, issue 3, September 2007,
p 686-702 Back
Q 1 Back
Q 110 Back
Q 129 Back
Stern Review, Technical annex to postscript, p 11 Back
Q 327 Back
Q 328 Back
Q 207 Back
Q 197 Back
Q 226 Back
Q 201 Back
Q 207 Back
Q 126 Back
Q 143 Back
Q 3 Back